Refinancing your home may cost more than you think

Posted by  on Nov 28, 2012

If you are considering refinancing your mortgage, current mortgage rates are certainly a big incentive. Years ago, borrowers were told to refinance if they could reduce their mortgage rates by 1 or 2 percent. Depending on the size of your mortgage and your goals, you may want to look into refinancing even when mortgage rates drop by as little as one-fourth or one-half percent.

You should compare the cost of refinancing with the savings you can generate by a refinance. Most homeowners opt to wrap their closing costs into their loan, but remember this increases your balance and therefore the amount you will pay in total for your home.

Other borrowers choose a "no-cost" refinance, which means that the closing costs are paid by the lender and the borrower repays the lender in the form of a slightly higher interest rate over the entire term of the loan.

While it may seem like a simple math problem to estimate that $2,000 in closing costs and a monthly saving on your loan payment of $100 means that you'll recoup your costs in 20 months, in reality, you should take another step to get a firm grip on the cost of refinancing.

Overall interest costs of refinancing

You can use a mortgage calculator for your individual refinancing estimates, but be sure to calculate the total interest you will pay for your mortgage under different scenarios. If you have had your mortgage loan for a long time, it may be less advantageous than you think to refinance into another 30-year fixed-rate home loan because by extending the payments you are also continuing to pay interest for a longer time.

For example, if you have a $300,000 mortgage at 5.00 percent for 30 years, your monthly principal and interest payments will be $1,610 and you will pay $279,768 over the life of your loan. After ten years of mortgage payments, you will have paid $137,300 in interest.

If you decide to refinance, after ten years the remaining balance on your loan (assuming you haven't made any extra payments to the principal) will be $244,026. You should compare these refinance choices in terms of your monthly payments and total payments:

  • 30-year fixed-rate loan at 4.00 percent: monthly payments of $1,165, total additional interest $175,381
  • 20-year fixed-rate loan at 3.75 percent: monthly payments of $1,447, total additional interest $103,207
  • 15-year fixed-rate loan at 3.00 percent: monthly payments of $1,685, total additional interest $59,310

Clearly, the 15-year loan will save the most in total interest, but your monthly payments will rise slightly. If you can manage the payments on a 15-year loan, you will save more than $116,000 in interest and have paid off your mortgage 15 years earlier.

Work with a reputable lender and your own budget to see which refinance scenario works best for you and your financial goals, but don't forget to consider the long-term consequences of extending your mortgage payments for another 30 years.

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